Pros and Cons of Using Arbitration Clauses in Home Inspection Contracts

We recently received a phone call from an InterNACHI member asking why the standard InterNACHI inspection contract does not contain an arbitration clause. It is a great question, and this article attempts to answer it. First, though, let’s review the different forms of dispute resolution that are available.

Before signing a contract, one issue to consider is how the parties will resolve any disputes. Generally, disputes are resolved by mediation, arbitration or a lawsuit (litigation). Because litigation has been the traditional method of resolving legal disputes in the United States, lawyers and judges often refer to mediation and arbitration as forms of alternative dispute resolution (ADR). As court calendars have become clogged in recent years with lawsuits, many of which are frivolous, the courts often encourage parties to try to resolve their disputes using alternate means.

Mediation

Mediation is a non-binding process in which a neutral mediator tries to help the parties reach a mutually agreeable resolution. Typically, the parties submit relevant information to the mediator prior to the mediation session so that the mediator can become familiar with the facts and the legal issues. They may also submit a confidential settlement statement so that the mediator understands each party’s “bottom line” before the mediation session. Mediation is usually very informal. During the mediation session, the mediator may meet separately with each party (and the party’s counsel) several times to offer his or her thoughts on the strengths and weaknesses of that party’s legal positions.

Most mediation clauses provide that the parties will split the costs of mediation. The contract should specify who the mediator will be; if it does not, it should specify how a mediator will be selected if the parties are unable to agree on a mediator.

The advantages of mediation are that it is relatively inexpensive, it may lead to a quick resolution, and it sometimes helps preserve good relations between the parties so they can do business together in the future.

One potential disadvantage of mediation is that it may not lead to a resolution of the dispute because the mediator has no power to require either party to agree to a resolution. The parties may invest time and money in mediation only to come away with no resolution at all. For this reason, it is beneficial for any ADR clause to include a provision directing a step in the process which addresses this, such as having arbitration automatically start in the event that no mutually acceptable mediated settlement is reached.

Arbitration

Arbitration is a form of dispute resolution in which the parties agree to submit their dispute to a neutral arbitrator rather than a court. The arbitrator acts like a judge; the arbitrator may hear testimony, review evidence, and enter binding rulings. Once an arbitrator makes a decision (usually called an “award”), the prevailing party may file that award in court and convert it to a judgment. The prevailing party may then enforce that judgment, provided that the process involved binding arbitration. In this case, the prevailing party may then enforce that judgment through the courts.

One advantage of arbitration is that it often leads to resolution of a dispute sooner than a lawsuit would. It may also be less costly than litigation because the process is more streamlined. Another advantage of arbitration may be the opportunity to select an arbitrator with specialized knowledge. For instance, in a home inspection-related dispute, the parties might choose an arbitrator with experience in contract law and the home inspection industry. Also, unlike litigation, arbitration is generally a private matter so that arbitration documents are not available to the public. Finally, in the case of binding arbitration, it may be difficult for the parties to overturn the arbitrator’s decision in court and, consequently, the potential for a lengthy appeal process is unlikely.

There may be disadvantages to arbitration. First, depending on the complexity of the case and the arbitration services retained, arbitration may be as expensive as litigation because most arbitrators charge $250 to $350 per hour. Second, the right to engage in discovery (take depositions, issue interrogatories, request documents, and issue subpoenas) may be limited due to the fact that arbitration is a private matter that falls outside of the traditional court system. Third, unless the contract is drafted properly, the parties may end up with an arbitrator with little expertise in the field of home inspections. Fourth, there is no right to a jury trial in arbitration. Fifth, it is virtually impossible to seek review of an arbitrator’s decision; in most states, a court may not overturn an arbitrator’s decision merely because the arbitrator did not properly apply the law to the facts of the case. Finally, most jurisdictions do not require the arbitrator to be a lawyer or to have any legal education, and the result may be that the parties sometimes have a non-lawyer arbitrator attempting to interpret complicated legal documents, statutes, and reported court decisions.

Arbitration generally comes in two flavors: binding and non-binding. Non-binding arbitration often has the same effect as its binding counterpart. Binding arbitration should be agreed to by both parties. This can be a bit tricky for an inspection agreement, as the client may not understand the ramifications of binding arbitration at the time the inspection agreement is signed. So, the key for inspectors, especially in light of the fact that contract adhesion often comes into play, is for the arbitration provision to not be viewed as oppressive. As non-binding arbitration provides an “out” for the litigants, it may not be viewed as oppressive. The second key component comes down to the cost of arbitration, which, depending on the services chosen, can easily reach thousands of dollars in out-of-pocket expenses up front and as the case progresses. Whichever form of arbitration is chosen, make sure that the associated costs are not onerous to either party.

Most arbitration clauses give the arbitrator authority to order the losing party to pay the costs of arbitration, as well as the expenses and attorney’s fees of the prevailing party.

The contract should specify who will serve as the arbitrator; if it does not, it should specify how an arbitrator will be selected if the parties are unable to agree on an arbitrator. Some contracts, particularly forms prepared by large national organizations, may require that any arbitration be conducted by the American Arbitration Association, Inspection Arbitration Services, or a similar national organization. The parties should familiarize themselves with the arbitration rules and fee structures of these organizations before agreeing to be bound by such a provision.

Mediation or Arbitration?

The primary difference between either binding or non-binding arbitration and mediation is that, while a mediator tries to negotiate a mutually agreed-upon settlement or remedy between the inspector and the client, an arbitrator acts as a disinterested third party whose primary aim is to determine liability, as well as possibly the appropriate damages required to settle the dispute.

Litigation

Litigation, of course, is the process that begins with the filing of a lawsuit. Litigation is expensive, but it may offer several advantages. First, litigation is governed by established rules of law, procedure and evidence. Knowing these rules ahead of time helps the attorneys for the litigants evaluate the strengths and weaknesses of their respective cases. Second, litigation allows a party to engage in discovery that may be necessary to find relevant evidence and/or to obtain information from non-parties who do not want to become involved. Third, litigants may opt for a jury trial, and there may be instances in which a jury trial is advantageous. Finally, a party who wishes to may appeal the trial court’s decisions on matters of law to a higher court.

Not Mutually Exclusive

Mediation, arbitration and litigation may not be mutually exclusive. A contract may require the parties to mediate and then require arbitration if mediation is not successful. Similarly, a contract may require mediation and then allow any party to file suit if mediation is not successful. Contracts can be drafted to automatically include mediation and arbitration as first and second steps to the dispute-resolution process.

Dispute Resolution Clauses Need Not Be Symmetrical

Additionally, a contract need not provide the same remedies for both parties. Many contracts provide that one party may file suit right away to collect money owed to it, but provide that the other party must resolve its claims through arbitration. In some recent court cases challenging the validity of clauses compelling arbitration for one party and not the other, symmetry became a factor in deciding whether the provision could be deemed as oppressive to one party. This concept should be considered when crafting a contract.

Why the InterNACHI Contract Does Not Include an Arbitration Clause

The decision as whether to utilize arbitration is a matter of personal preference, which is why InterNACHI does not include an arbitration clause in its inspection agreement. Additionally, if an inspector wants to include an arbitration clause in his contract, the decision as to which arbitration service to use plays a huge part in the process for all the reasons discussed in this article. In some instances, and depending on the fees charged by the arbitration service, arbitration may favor the party with more money if the costs associated with arbitration are excessive. Consider using fixed-price arbitration services, as opposed to paying a minimum retainer based on an arbitrator's hourly fee for the projected hours of his or her involvement. The party with more money may also be able to hire investigators and researchers to make up for the fact that discovery in arbitration is limited. In the end, it will be up to the arbitrator to decide whether to accept or exclude any evidence or testimony offered. There are pros and cons to arbitration, as traditional rules of law don't necessarily apply to all cases.

Those who favor arbitration clauses for inspectors are betting that the high cost of arbitration will deter customers from making claims against inspectors, but proponents of arbitration forget that many laymen feel they can initiate arbitration without a lawyer. On the other hand, filing a lawsuit (except in small claims court) requires the claimant to first spend money to retain a lawyer. In our view, it is easier for a customer to initiate arbitration than to file a lawsuit.

In both arbitration and in traditional lawsuits, the defendant-inspector can file a motion for summary judgment or a motion to dismiss right away based on the language in the contract, which is designed to protect the inspector. That is, if the contract is drafted properly, the inspector may be able to get the lawsuit dismissed without going through a lengthy trial.

If you do include an arbitration clause in your inspection agreement, make sure you specify in advance who the arbitrator will be, along with the costs associated with arbitration (as opposed to traditional attorney's fees and court costs), whether you will have binding or non-binding arbitration, and that the arbitrator must award attorney's fees and costs to the winner. Make sure the clause states that the arbitration will take place in the county where your business is located. Also, if you don't know who to appoint as an arbitrator in the contract, insert the following: "If the parties cannot agree on an arbitrator, they agree that InterNACHI's general counsel may appoint the arbitrator, and all parties release InterNACHI and its counsel from any liability in connection with that appointment."

Conclusion

The InterNACHI contract has been developed and refined as the result of years of experience. It provides tremendous legal protection to the inspector, but it is concise enough that it does not frighten potential customers.

Inspectors who wish to modify the contract to include mediation and/or arbitration clauses should consider the pros and cons of such clauses and discuss them with counsel of their choice.